TV Stations: What’s the Big Deal?

In the race to become bigger in a media world being disrupted by changes in technology and viewer preferences, it looks like TV station groups, Sinclair Broadcast and Tribune Media, will be searching for new suitors, starting tomorrow.  August 8^th is the deadline for the parties to walk away from their $3.9 billion merger, something that, after the FCC’s July 26^th decision to refer its public interest review of the merger to an administrative law judge, became more likely they would do.

TV Groups say they need greater scale to use as leverage with advertisers and multichannel video programming distributors(MVPDs) as advertisers have more outlets to choose from putting downward pressure on ad prices and MVPDs, through consolidation, are bigger and have more heft in negotiating retransmission agreements that work best for them.

But, how much scale is necessary? As separate entities, Sinclair and Tribune have 184 and 40 major network affiliate stations in 89 and 33 markets, respectively.  Sinclair is in 37 percent of US households, while Tribune is in 44 percent.  I imagine they already have strong bargaining positions with small businesses looking to place ads on local TV channels.  I imagine they already have mutually dependent relationships with broadcasters, ones that neither party at the negotiating table wants to risk upsetting.  I imagine they don’t need much national scale to produce local news. 

	Network Affiliates
Affiliation	Tribune	Sinclair
ABC	3	30
CBS	6	25
CW	12	37
FOX	14	43
MY Network	3	31
NBC	2	18
Total Major Network Affiliates	40	184

  Source: 10K Reports

Size (and dominance) can easily become inefficient and harmful to consumers in the form of higher prices, fewer choices, and less innovation.  It may also add to the temptation and ease of cooperating with the few remaining firms in the industry on shared interests such as higher advertising prices (as is being investigated allegedly by the DOJ.)  It raises the question of whether these station group mergers (another one is the $3.65 billion Gray and Raycom deal) are ploys to convert local markets into national ones to spread costs across more units or spread agendas. 

Sidebar:

Television programming, aggregated by broadcast and cable networks is provided via broadcast or multichannel subscription services.  If a household only wants to watch broadcast network programming, the over-the-air signals can be picked-up for free by using an antenna and a tuner that transmit the Very High Frequency (VHF) and Ultra High Frequency (UHF) signals.  Broadcast spectrum is licensed by the FCC on an 8-year renewable term to individual and group owners to serve the public interest of communities within designated metropolitan areas (DMAs).  In 2015, there were 210 DMAs, of which 183 had three or more full-power commercial television stations assigned to them.  In many of the largest DMAs, the top broadcast networks (ABC, CBS, NBC, and FOX) own and operate their own stations.  Programming on local television stations comes from the broadcast networks, purchases of syndicated television shows, and production of original content, such as local newscasts and coverage of local and regional events. 

Broadcast TV stations transmit over two alternative broadcast bands – very high frequency (VHF) or ultra high frequency (UHF).  Nationwide, the maximum percentage of U.S. households that a television group can serve is 39 percent. The cap discounts the audience reach by 50% if UHF technology was used prior to 2009, because it historically had weaker over-the-air signals compared to VHF.   In 2016, the FCC grandfathered the UHF rule stating that it was outdated given the conversion to digital broadcasting in 2009.  However, in April of 2017, the FCC restored the practice of discounting and the rule change was upheld in Court on appeal.

While ad-supported local broadcast TV stations provide their programming free over the air, 86 percent of households receive these stations through the paid subscriptions of MVPD providers (cable, direct broadcast satellite (DBS), and telecom firms) who bundle broadcast and cable networks into program tiers.   Local broadcasters are given the option of either demanding carriage on their local MVPD systems (Must-Carry or Carry One, Carry All) or negotiating with those systems for compensation for carriage (Retransmission Consent).  If the broadcaster elects Must-Carry status, then they are generally guaranteed carriage and no compensation is involved.  The arrangement is negotiated every three years and typically smaller stations choose Must-Carry status.  Larger broadcasters prefer Retransmission Consent because they receive cash or in-kind compensation from cable operators that find it necessary to carry the major networks to attract and retain subscribers.  On average, nearly a quarter of broadcast station’s revenues comes from fees paid by MVPDs.  TV stations typically share a portion of the retransmission consent fees with their broadcast network affiliate.

What lies ahead for Disney

On Friday, Disney and Fox shareholders approved the $71.3 merger that will transfer Fox’s 20^th Century film and TV studios, a 30 percent share in Hulu, and cable networks (FX Networks, National Geographic) to Disney when the deal is completed in the first half of 2019.  Next year will be a transformative year for Disney.  In addition to this deal closing, the media giant will launch its own direct-to-consumer streaming service consisting of live action and animated movies, and end its three-year exclusive distribution agreement with Netflix.  Owning the relationship with the customer is a critical part of Disney’s [slight] pivot away from being the anchor tenet (with ESPN) in the Pay-TV bundle. 

When it terminates its agreement with Netflix, Disney loses access to over 100 million global (52+ million U.S.) subscribers and the associated licensing revenue.  Can it make these losses up with a sufficient number of its own subscribers willing to fork over $X.XX per month?  I’m not sure!  After Netflix, the largest streaming services, by number of subscribers, are Amazon, Hulu, and HBO Now.  Disney most closely resembles number four, HBO, a firm that is trying to continue to monetize a position on the pay-TV bundle while carving out a “go it alone” path.  HBO Now had only 5 million subscribers in 2017.  Disney will need a way more subscribers than that to make this new strategy work.

Top Streaming Services in 2017	Number of subscribers (millions)
Netflix	52.8
Amazon	26.0
Hulu	17.0
HBO Now	5.0
Showtime	2.5
CBS All Access	2.5
Sling TV	2.2
Starz	2.0
YouTube Red	1.5
DirecTV Now	1.0
Hulu with Live TV	0.5
PlayStation Vue	0.4
YouTube TV	0.3
fuboTV	0.1

Source: eMarketer

ESPN is losing scale. Can it make it up in scope?

In 2010, ESPN reached its peak number of subscribers at 100 million.  In the seven years that followed, that number dropped by 12 percent to 88 million as emboldened (or fed-up) Pay-TV subscribers cut the cord.  For Disney, ESPN’s parent, the revenue loss is significant.  According to SNL Kagan, Disney was paid $7.21 per subscriber in 2016 by cable and satellite providers.  That number jumped to $9.06 if the sister networks (ESPN2, ESPNU, SEC Network) were included.  Assuming no change in programming fees, ESPN losses between $86.5 and $108.7 million in annual revenue for every 1 million decline in subscribers.  (Note: ESPN’s subscriber loss has averaged closer to 2 million per year.)

In 2017, Disney/ESPN spent approximately $7 billion on sports programming rights.  Just to cover these costs, ESPN needs 88 million subscribers paying $6.63/month.   With acceleration in Pay-TV subscriber losses expected, ESPN is going to have to get creative to sustain profitability.  It may control the bleeding somewhat by sports fans adding the newly launched direct-to-consumer app, ESPN+, that Disney is charging $4.99 per month for.  But, with this pricing model, Disney is going to have to add nearly 2 customers for every one lost by cord-cutting.  Brand reputation aside, this may be very difficult to do in an increasingly fragmented media market.     

Zero-rating is a good for consumers, right?

“Going forward, the Federal Communications Commission will not focus on denying Americans free data.”  FCC Chairman Ajit Pai, February 3, 2017.

How can a recent court case pertaining to the credit card market inform us on whether the practice of zero-rating by internet service providers (ISPs) is good or bad for consumers?  On June 25^th, in a 5-4 ruling, the Supreme Court found that the antisteering provisions in American Express’s merchant contracts were not anticompetitive in violation of Section I of the Sherman Antitrust Act.  In the Court’s majority opinion, Justice Thomas wrote that the value of a credit card network depends on the mutual interdependence of two sides —cardholders and merchants— and therefore should be treated as one market instead of two separate markets.  Specifically, if merchants were permitted to steer patrons to use alternative payment cards and, as a result, the Amex card was used less frequently, some cardholder perks would go away and interbrand competition would be reduced.

How might this concept of one market with a two-sided platform relate to the internet and the practice of zero-rating by fixed and mobile ISPs?  In its simplest form, zero-rating excludes the bytes associated with some internet traffic from counting towards the allowed monthly data amount paid for by the ISP subscriber.  The more bytes excluded the less likely the subscriber will encounter his/her data cap and have to pay the universally-disdained overage charges.  Zero-rating benefits the consumer as s/he receives more content over the network without overtly paying for it.  Moreover, to lure and retain subscribers, ISPs have upped the ante by offering more and more plans that exclude content from data caps.  In the short-run and supportive of Chairman Pai’s statement, there appears to be a net competitive benefit to those on the consumer side of the internet market. 

But, what about the other side of the platform and might what happens there impact the consumer in the long run?  To tie back to the Amex case, let’s say that the content owners and ISPs are the equivalent of the credit card companies and merchants, respectively.  What if the ISPs favor some content (e.g. HBO) over another (e.g. Comedy Central)?  Maybe it is because the content owner has tremendous brand loyalty that the ISP wants to leverage for its bottom line.  Maybe it is because the content owner can pay the additional fees to ensure its content is zero-rated?  Maybe it is because the content is owned by the ISP? 

These pricing strategies fall into the category of price discrimination, where different customers are charged different prices even though there are no differences in costs.  They are perfectly legal IF they do not harm competition (Section II of the Clayton Act).  We’ve all gone to the movies or checked into a hotel knowing that the person sitting in the seat or in the room next to us might be paying a different price than we are. The price difference could be because they are a different age, they made the reservation at a different time, or they participate in a loyalty program.  Competition is not harmed in these markets and there are some efficiency gains from the practice.  But, what about its use in content distribution over the internet?  While the FCC Chairman doesn’t want to address zero-rating and “free” data for consumers, favoritism on the content-side may eventually impact demand and what is paid on the consumer-side of the market by reducing interbrand competition.  The probability of competitive harm increases if regulators approve more vertical mergers without behavioral safeguards and give latitude to firms like AT&T to favor their own content through zero-rating schemes and other ploys.

See: https://www.supremecourt.gov/opinions/17pdf/16-1454_new_1a72.pdf and http://transition.fcc.gov/Daily_Releases/Daily_Business/2017/db0203/DOC-343345A1.pdf

A Bird in the Hand...DOJ Settlement in Disney/Fox Acquisition

Today, the Department of Justice filed a proposed settlement of its civil antitrust lawsuit in the U.S. District Court for the Southern District of New York that would require Disney to sell Fox’s 22 regional sports networks within 90-days of closing the deal.  The sale of the RSNs would resolve the agency’s competitive harm concerns that a combined firm could charge much higher prices for cable sports programming.  While it is a huge concession, Disney has agreed to the settlement terms.  After all, in addition to its international assets, Disney gets Fox’s production studios, cable networks (excluding news, business, and sports), and the 30 percent stake in Hulu.

In a memo to employees, Fox CEO James Murdoch and co-executive chairman Lachlan Murdoch acknowledged that, while the “decision is a big step forward towards the completion of our Disney transaction and the creation of new ‘Fox’,” the deal is not done yet.  Regulatory approvals outside the United States and stockholder approval are still necessary. 

And, what about the “fly in the ointment”, Comcast?  Will Comcast re-enter the fight when all the momentum seems to be strongly in Disney’s corner, including Fox’s most certain hesitation in giving up regulatory approval of one deal to chase another? Or, is it time for Comcast to walk away and consider the acquisition of content from other market participants (e.g. Lionsgate) or look to make a bid for some of the assets Disney will need/want to shed?  Could Comcast scoop up the RSNs?  Why not?  Could Comcast make a move to buy Sky?  Why not? As a pay-tv distributor in the U.S., the Sky assets make way more sense with Comcast.  These alternative, smaller moves may be much better for Comcast in the long run.

https://www.justice.gov/opa/pr/walt-disney-company-required-divest-twenty-two-regional-sports-networks-order-complete

Control of the Box Office

According to Box Office Mojo, just seven firms accounted for approximately 90 percent of movie ticket sales during the five-year period between 2013 and 2017.  This is despite releasing less than a quarter of the movies in each year.  If Comcast or Disney are successful in acquiring the film studio of 20^th Century Fox, the combined market share will be approximately 30 percent.  These content creation assets are so important to later distribution on the small screens of television, tablets, game consoles, and mobile devices AND to cross-selling and merchandising.  Let's call them "must-haves"!

So, what should the losing bidder do?  With Time Warner off the market because of the AT&T acquisition last week, Sony, Lionsgate, and Viacom become the possible partnership targets.  Lionsgate is particularly attractive with its library of 16,000 film and TV titles and its Starz cable/satellite network.  Lionsgate could also be attractive to Apple and Facebook who look to quickly scale content ownership.  (Note: In 2017, Netflix and Amazon spent $6.3 billion and $4.5 billion on original content, respectively.  By contrast, Apple and Facebook ONLY spent $1 billion.)

Content is still KING! 

Firm	Market Share
	2017	2016	2015	2014	2013	Avg. 2013-2017
Disney	21.8	26.3	19.8	14.9	14.9	19.5
Time Warner (WB/New Line)	18.4	16.7	16.9	18.8	21.3	18.4
NBC/Universal	15.0	14.1	22.3	11.4	13.3	15.2
News Corporation (Fox)	12.9	13.3	12.4	17.9	10.2	13.3
Sony	9.8	8.3	8.9	12.0	10.6	9.9
Lionsgate	8.0	5.8	5.9	6.8	9.3	7.2
Viacom (Paramount)	4.8	7.7	5.9	9.7	8.4	7.3
% of Box Office	90.7	92.2	92.1	91.5	88.0	90.9
If Disney/Fox	34.7	39.6	32.2	32.8	25.1	32.9
If Comcast/Fox	27.9	27.4	34.7	29.3	23.5	28.6
http://www.boxofficemojo.com/studio/?view=company&view2=yearly&yr=2018&p=.htm

Could It Be That Three Competitors Would Be Better Than Four?

Approximately 10-days ago and two-months after a merger announcement, Sprint and T-Mobile filed applications with the FCC requesting its approval of the transfer of Sprint’s licenses and authorization to T-Mobile.  What’s the likelihood that regulators will approve this horizontal merger that will reduce the number of major competitors in the U.S. wireless market from four to three?

No Way It Will Happen

·         The increase in concentration will harm competition.  According to the FTC/DOJ Merger Guidelines, the industry is already highly concentrated (Herfindahl Hirschman Index > 2500).   Post a hypothetical merger, the HHI would jump by over 400 points, from 2,460 to nearly 2,900.  With fewer competitors, keeping track and matching rivals’ moves becomes easier.   Less competition could translate into higher prices for consumers.

·         T-Mobile, the Un-Carrier, and Sprint, the smallest of the four major carriers that competes on price, combine to become more like AT&T and Verizon instead of continuing to be disruptive forces.

·         What is different today versus the proposed AT&T/T-Mobile merger in 2011 and previous attempts by Sprint and T-Mobile to combine in 2014 and 2017?  Critics of the merger would argue “not much.”  In those previous tie-ups, regulators strongly signaled that merger approval would not happen as four is always better than three.

Maybe It Will Happen, This Time

·         T-Mobile and Sprint state that the combined firm will realize $6 billion in annual cost savings.  They argue that together they can accelerate 5G deployment (innovation) and “create robust competition in the 5G era.”[1]

·         The merger partners are committing to expanding rural mobile coverage and offering fixed wireless coverage that would be competitive with the in-home broadband services offered by the likes of Comcast, AT&T/DirecTV, Verizon FiOS, Dish Network, and Charter.  This market entry would accelerate cord-cutting and “deliver real choice and real savings to consumers.”[2]

·         The competition has gotten bigger.  AT&T acquired DirecTV and Time Warner.  Verizon bought AoL and Yahoo.  Both firms have announced plans to introduce 5G in late 2018/early 2019.

·         Verizon’s CEO is quoted as saying “Competition will probably be different if they [Sprint and T-Mobile] are together, but it is still going to be a very competitive market, so we don’t care.”[3]

·         Both Comcast and Charter have entered the wireless market through reseller agreements with Verizon.  These are formidable new competitors that can leverage scale and scope to gain market share.

·         Sprint Chairman, Masayoshi Son, and President Trump are good friends.

I’d put the odds at 60/40 of approval of the deal this time, assuming regulators get some guarantees from the combined firm, particularly in rural market coverage.

---

[1] https://newtmobile.com/supercharging-the-uncarrier/.

[2] Ibid.

[3] https://www.geekwire.com/2018/verizon-ceo-brushes-off-t-mobiles-sprint-merger-dont-care-answer/.